The Western Sydney residential development market: boiling over or simmering?

Open up any newspaper these days and the commentary around the property market reads: “housing bubble”, “apartment oversupply” and “housing market collapse”. You may well think that one of the biggest sources of wealth in this country is about to come tumbling down like the proverbial house of cards. Sensationalist or an accurate prediction?

Days of the past

Within the last 10 years, developers have been able to secure a development site at a purchase price that would start with a profit margin of 20%. By the time the site was completed, developers achieved super profits of 30% to 40% as they surfed the market’s growth wave, benefiting even those paying above market price to secure development sites.

What has changed in property development?

The current property development environment is more challenging and it looks as though this will continue to be for some time.

The days of easy money where anyone can undertake development are over. Development financing has changed. The Big 4 banks have introduced new hurdles to overcome, and if developers are not well-positioned with their bank, they may need to source funds from non-traditional providers. Funding is constrained even though interest rates are low; land prices are increasing; and apartment buyers have become more cautious.

Developers need to recalibrate their feasibilities for new projects to incorporate higher developer equity contributions, slower sale rates, higher development finance costs, conservative revenues, and higher construction costs. Developers ignoring these fundamental market changes and pressing ahead with a project will be proceeding at their own peril.

Opportunities are emerging for astute buyers to step in where inexperienced or over-ambitious developers are struggling to make financial returns on projects. In fact, the outlook for these experienced developers is quite strong as the compass shifts back towards the key attributes of good property development – site selection, design and marketing to customers, and well-controlled quality construction.

Developers cannot rely on sale price escalations to make their projects profitable – the focus needs to be more strategic. Product differentiation targeted to geographical areas that are delivering ‘game-changing’ localised benefits of accessibility and amenity will need to be sought.

Growth in Western Sydney

Western Sydney is one of these game-changing areas. It is undergoing an unprecedented level of investment in infrastructure projects including WestConnex, Sydney Metro Northwest (formerly the North West Rail Link), Parramatta Light Rail, the metro line to Sydney Olympic Park, the Parramatta Square redevelopment, Badgerys Creek airport, and multiple health and education precinct developments such as Westmead.

All of these projects are expected to deliver increased connectivity, accessibility and employment opportunities, which contribute to higher-than-average price growth in geographical areas that are adjacent or near such projects.

There is much commentary on the ‘approvals’ for new housing and apartments being at a record level, with an impending deluge of apartments coming on to the market. It is well understood in the property sector that just because apartments have been approved doesn’t mean they will be built. The ‘building commencements’ statistic is more relevant and accurate in measuring apartment supply.

Look at Parramatta for example – it is experiencing unprecedented levels of apartment construction, as a result of the many infrastructure projects driving investment. While sales activity may have slowed in-line with the general market and some investors are exiting the market due to regulator-led slowdown and new lending parameters, there are no signs of distressed developers discounting apartment prices. In most cases actually, if a residential development is being bank funded, then typically 50% of the apartments in the project would have been presold before construction has commenced, so the risk transfers to the settlement stage upon completion of the project.

So what’s ahead?

Mirvac, one of Australia’s largest developers, revealed a rise in the default rate for the settlement of off-the-plan residential sales in the general market, as foreign and local buyers struggle to finalise payments on time. This is an indicator of what the Western Sydney market needs to be aware of as settlement risk needs to be properly managed. However, we expect settlement risk to temper as potential buyers of off-plan units become conditioned to the new bank lending parameters and foreign buyers also become aware of the additional costs.

With anticipated population growth and strong market fundamentals on the back of game-changing activities in the region, Western Sydney is well-positioned and the medium-term outlook for residential developers is promising.

The Western Sydney residential apartment market probably did boil over for a while, but the heat came off without too much being burned and it’s now simmering at a manageable level.

Have more questions about Western Sydney’s residential apartment development market? Read another blog piece by David and Fred.

David is a partner in Deloitte's corporate finance team in Western Sydney.
His team assists clients with corporate finance advice across all aspects of M&A activity and capital raisings, including acting as Investigating Accountant to IPO.